Wednesday, August 26, 2009

Are we at the bottom of the crisis?

It is difficult to say whether we are.

While most "authorities" are happy to have announced teh end of the crisis, we need to keep in mind the following factors:

1. I have commented earlier that there is too much printed money in the world, as a result of over-printing over the last 20 or so years. This money acts as a natural booster of the economy, because no one who holds money likes to keep it under the mattress so to speak. In other words, there is a systemic "push" to invest, and everyone has been indoctrinated in the last 20 years to believe that equities will always outperform other forms of investment "in the long run" (whatever that is). So even Pension Funds which should have an interest in stable long term returns, and therefore should invest largely in bonds, tend to invest largely in equities. Beliefs about where the money should go act as a self-fulfilling prophecy - money goes to where people believes it should go, creating a demand for equities that is systemically too high (i.e. higher than it should be, given fundamentals). That is what explains "animal spirits" in the stock market.

2. We can therefore say that the crisis is over not when investors rush into the stock market (which has happened, and will happen several times before the crisis really eands), but when real expenditure returns to the market. That is mostly cosumer expenditure historically, but there is no reason why capital expenditure should not take its place. In fact, tax incentives to increase capital expenditure in relation to green technologies would be the most intelligent way of increasing consumption, but no one is doing that in any substantial way at present, leaving it to private consumption to drive the economy. What about government expenditure? It is of course a significant factor at present, but it can never be large enough to really drive the economy, first because it is not large enough in relation to private and capital expenditure and because it usually takes too long and is usually not productive enough (governments tend to spend on defence, infrastructure and social services). Briefly, government expenditure is up practically all over the world, but capital and private expenditure is not up - and till that improves the crisis will not be over.

Private expenditure tends to be driven by three factors (beliefs, employment levels and house prices). The beliefs can be manipulated by government propaganda and stock prices. Employment figures can be manipulated by governments to a certain extent. House prices tend to be relatively objective, though of course governments can and do intervene in the housing market.

We have been told that employment will not pick up for some time. But that is simply what the US government believes, or would like us to believe.

As for housing, The S&P/Case-Shiller 20-City Composite Index fell is still declining, having fallen 15.4% y/y in June 2009 after declining 17.1% y/y in May.

By June 2009, average home prices were at similar levels to what they were in early 2003.

From the peak in mid-2006, the 10-City Composite is down 32.5% and the 20-City Composite is down 31.4%. If one agrees that the peak was hugely exaggerated, the questions are: (a) has the decline now reached the lowest it is going to reach? and how long will it be before there is a sustained (even if slow) rise in price of say 3% or more a year? My answer to (a) is "No", though I do not know how much further house prices have to fall (I hope not a lot). My answer to (b) is that no one knows, not even governments who have made public their "belief" that house prices, employment levels and the economy in general will start coming out of the recession in 2010.

For the reason that I mentioned at the start of this post, too much money sloshing around the system creates systemic distortion and unpredictability. It can (as it has already) cause an apparent end to the crisis very much sooner (or very much later) than 2010.

My view continues to be that we will continue to yo-yo along something like the bottom, reaching marginally lower levels (which will be systemically discounted - at least, so I hope!) and touching marginally higher levels (which will be systemically heralded as the end of the crisis.

Certainly it helps if large numbers of business leaders and ordinary people behave as if the crisis is over.

But watch the fundamentals I mention above.

Governments have begun to put many sensible things in place, which I have been arguing for, and which are helping to resolve the crisis, but we still have the unresolved question of toxic assets - all that we have done is move them from private hands to the hands of governments. In one or two small countries, we see encouraging signs that at least some of the toxic assets are no longer toxic. Assets become less toxic or eventually beneficial as the economy improves, but become more and more toxic as the economy deteriorates. It is only as the bulk of toxic assets in the world economy as a whole are sorted out that the fundamentals will have been addressed sufficiently. Sphere: Related Content

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